Summary: it seems logical on many levels to screen for companies that have large exposure to southern Europe or Europe as a whole. Find the exposed businesses and follow the stocks lower as uncertainty and eventual austerity take hold. In the specific case of Solera Holdings where 40% of revenue is "Europe" this logic does not apply and may have pushed the stock to a level where owning the business is attractive. Upside to $66 would be 20x CY12 EPS of $3.30 (+30-35%) while in a poor macro setting downside could be 15x $3 or 8% below current levels. Such precision is usually misplaced in my opinion, but the highly predictable nature of cash flows is a benefit of the model that allows for the estimate of limited downside.

 

It has been almost three years, but please refer to krusty175's writeup of the core business which is still relevant today.

 

• Fx forced guidance slightly lower with Sept 2011 results, but the core business did quite well. Business has a net $45m exposure to CHF because that is where the core estimating database sits. The stronger the CHF vs USD and EUR, the larger the hit to headline numbers.
• Market overly focused on piece of business that comes from Europe. This is really built country by country and considers trends in miles driven, insurance claims filed, gas prices, accident severity, etc. The focus on austerity might imply less driving, fewer cars fixed and slower GDP growth overall. What this fails to consider is the continued rate of penetration and secular market share growth for electronic claims. This is the classic analog to digital transition that is happening because it saves insurers money.

What has not changed?

• Long-term secular opportunity, which continues to play out even in a more volatile economy. We are still in the middle innings of adoption of electronic auto insurance claims. SLH grew organically throughout the last downturn because they prove to their customers that they save money vs the alternative. Moving from the old way - fax, hand written estimates, phone calls, visits from adjusters - to the new way (online) is a huge time and money saver. Penetration in the US is effectively 100% and other geographies are headed there over time. But, there's still room to run even in countries like Spain which might be at about 80% (yes, referencing Spain in a bull case...). The path to 100% can be very quick like Romania where two large insurers signed up concurrently or it can be steadier.
• Visibility. This business is transactional outside the US and subscription based here at home. While accidents are a function of variables like miles driven, gas prices and other economic indicators, the rate at which we get in accidents and repair cars is very slow to change. 
• Competitive structure. SLH's database of auto parts, repairs and other info by make and model would take years and hundreds of millions of dollars to replicate. At #1/2 in every non-US market (at home is a three horse race with CCC and Mitchell) SLH's crown jewel is this database and keeps it entrenched as the international leader in this business.
• Quality of management. While bears would point to continued selling on the part of CEO Tony Aquila or some aggressive mgmt practices that burn out talent quickly, I maintain these are the types of managers you want running a business you own. They are ruthless with their capital allocation and what they demand from their team, but Tony rewards managers with stock appropriately for a job well done. Moving the company's headquarters from San Diego to Dallas is an example of actions in the best interest of shareholders (time/efficiency given senior mgmt travel to Europe & elsewhere). 

 

Metrics for the past nine quarters through June show that SLH hasn't missed a beat in its subscription (US) or transactional (intl) markets.  

June-09 / Sept-09 / Dec-09 / Mar-10 / Jun-10 / Sep-10 / Dec-10 / Mar-11 / June-11

Claims volume growth 2.3% 2.9% 0.3% 3.9% 3.8% 2.6% 3.1% -1.0% 0.0%

Revenues per claim growth 4.0% 5.4% NA NA 4.4% 14.8% 5.6% 10.1% 8.9%

Revenue growth organic - constant currency 5.2% 5.3% 3.5% 3.7% 4.4% 5.1% 6.8% 7.0% 5.5%

Adjusted EBITDA growth - constant currency 24.6% 25.7% 36.9% 16.8% 26.6% 19.3% 13.2% 14.2% 8.5%

 

• Europe will still grow as SLH improves the value proposition for insurance customers. While miles driven and claims may decline a bit, adding services to its bundle of products and bolt-on M&A means the cash flow here will continue to grow.
• Incremental margins are great. It is prudent to assume the pace of margin accretion will slow. After all, EBITDA margins have gone from 27.4% to 43.1% over the past five years. But as SLH continues to leverage its core estimating database, incremental EBITDA margins are still in the low 60s. But, the sell-side is modeling a large slowdown in incremental margins towards current levels. 
• Co has to update long-term targets soon. SLH's initial plan was for $1bn in revenue and $400m in EBITDA by FY14. This was later revised to $450m as margins beat internal expectations. Now with the company at a run rate of $800m in revenue and $350m in EBITDA it is apparent that the company will get to these targets before FY14 with one more decent-sized deal and organic growth. A focus on what the company could look like in the medium-term could help investors focus on a TAM much larger/broader than the current estimate.
• While this thesis is long-term in focus, the sell-side is modeling flat EPS from the Sept to Dec quarter this year. In lieu of any large Fx movements over the next 6-7 weeks, the December quarter is typically stronger as insurance customers exhaust budgets and body shops see more seasonal activity. For what it's worth, the company should beat expectations for fiscal Q2.
• China and India are early days and not included in guidance, but loss ratios will eventually come into focus for insurers after the land grab for customers. These markets are harder to value but SLH should be #1/2 here like it is in every market.

 

 

There are no publicly traded peers although I would guess that the PE owners of slower growth competitors like CCC and Mitchell would think 12x trailing EBITDA is reasonable for their companies. Historicals aren't necessarily a guide, but the stock hasn't really traded far below 20x ttm P/E in the prior downturn.

• Upside to $64 = 20x $3.20 in 2012 adj EPS or 18x FCF
• Downside to $45 = 15x $3 in 2012 adj EPS

The big picture is that this is a secular grower with > 30% operating margins, visible and recurring revenue, strong cash flow profile / high ROIC. It's a business where an owner can have a high degree of conviction in adding should the stock see more volatility worldwide.

Will cut it off here for Q&A rather than rehash why this is a great business.

 

Continued secular growth in electronically filed auto insurance claims

Dec-11 EPS beat

Update to long-term targets of $1bn rev and $450m EBITDA

Capital allocation (buyback announced today, higher dividend, more bolt-on M&A)